The Indian
Software Industry has been the beneficiary of direct tax incentives under the
provisions like Sections 10A, 10AA & 10B of the Income -tax Act, 1961 in
respect of their profits derived from the export of computer software. These
provisions prescribe incentives to “units” or “undertakings”, established under
different schemes, which are/were deriving profits from export of computer
software subject to fulfilling the prescribed conditions.

2. It has been
represented by the software companies that several issues arising from the
above mentioned provisions are giving rise to disputes between them
and the Income-tax authorities leading to denial of tax benefits and consequent
litigation and, therefore, require clarification. Various issues highlighted by
the Software Industry have been examined by the Board and the following
clarifications are hereby issued -

(i) (a) WHETHER
“ON-SITE” DEVELOPMENT OF COMPUTER SOFTWARE QUALIFIES AS AN EXPORT ACTIVITY
FOR TAX BENEFITS UNDER SECTIONS 10A, 10AA AND 10B OF THE INCOME TAX
ACT, 1961; AND

(b) WHETHER
RECEIPTS FROM DEPUTATION OF TECHNICAL MANPOWER FOR SUCH “ON-SITE” SOFTWARE
DEVELOPMENT ABROAD AT THE CLIENT’S PLACE ARE ELIGIBLE FOR
DEDUCTION UNDER SECTIONS 10A, 10AA AND 10B.

(a) CBDT had
earlier issued a Circular (Circular No. 694 dated 23.11.1994) which provided
that a unit should not be denied tax-holiday under sections 10A or 10B on the
ground that the computer software was prepared ‘on-site’, as long as it
was a product of the unit, i.e., it is produced by the unit. However, certain
doubts appear to have arisen following the insertion of Explanation 3 to
sections 10A and 10B (vide Finance Act, 2001) and Explanation 2 to
section 10AA (vide Special Economic Zones Act, 2005) providing
that “the profits and gains derived from on site development of
computer software (including services for development of software) outside
India shall be deemed to be the profits and gains derived from the export of
computer software outside India”, and aclarification has been sought on
the impact of the Explanation on the tax-benefits as compared to the
situation that existed prior to the amendments.

The matter has
been examined. In view of the position of law as it stands now, it is clarified
that the software developed abroad at a client’s place
would be eligible for benefits under the respective
provisions, because these would amount to ‘deemed export’ and tax benefits
would not be denied merely on this ground. However, since the benefits
under these provisions can be availed of only by the units or undertakings set
up under specified schemes in India, it is necessary that there must
exist a direct and intimate nexus or connection of
development of software done abroad with the eligible units set up in
India and such development of software should be pursuant to a contract between
the client and the eligible unit. To this extent, Circular No. 694 dated
23.11.1994 stands further clarified.

(b) It has also
been brought to notice that it is a common practice in the software industry to
depute Technical Manpower abroad (at the client’s place) for software
development activities (like upgradation, testing, maintenance,
modification, trouble-shooting etc.), which often require frequent interaction
with the clients located outside India. Due to the peculiar nature of software
development work, it has been suggested that such deputation of
Technical Manpower abroad should not be considered detrimental to the benefits
of the exemption under sections 10A, 10AA and 10B merely because such
activities are rendered outside the eligible units /undertakings.

The matter has
been examined. Explanation 3 to sections 10A and 10B and Explanation 2 to
section 10AA clearly declare that profits and gains derived from ‘services for
development of software’ outside India would also be deemed as profits derived
from export. It is therefore clarified that profits earned as a result

of deployment of
Technical Manpower at the client’s place abroad specifically for software
development work pursuant to a contract between the client and the eligible
unit should not be denied benefits under sections 10A, 10AA and 10B provided
such deputation of manpower is for the development of such software and all the
prescribed conditions are fulfilled.

(ii)WHETHER IT IS
NECESSARY TO HAVE SEPARATE MASTER SERVICE AGREEMENT (MSA) FOR EACH WORK
CONTRACT AND TO WHAT EXTENT IT IS RELEVANT.

As per the practice
prevalent in the software development industry, generally two types of
agreement are entered into between the Indian software developer and the
foreign client. Master Services Agreement (MSA) is an initial general
agreement between a foreign client and the Indian software developer setting
out

the broad and
general terms and conditions of business under the umbrella of which specific
and individual Statement of Works (SOW) are formed. These SOWs, in fact,
enumerate the specific scope and nature of the particular task or project that
has to be rendered by a particular unit under the overall ambit of the

MSA.
Clarification has been sought whether more than one SOW can
be executed under the ambit of a particular MSA and whether SOW should be given
precedence over MSA.

The matter has
been examined. It is clarified that the tax benefits under sections 10A, 10AA
and 10B would not be denied merely on the ground that a separate and specific
MSA does not exist for each SOW. The SOW would normally prevail over the
MSA in determining the eligibility for tax benefits unless the

Assessing Officer
is able to establish that there has been splitting up or
reconstruction of an existing business or non-fulfilment of any other
prescribed condition.

(iii) WHETHER
RESEARCH AND DEVELOPMENT (R&D) ACTIVITIES PERTAINING TO SOFTWARE
DEVELOPMENT WOULD BE COVERED UNDER THE DEFINITION OF “COMPUTER SOFTWARE”
STIPULATED UNDER EXPLANATION 2 TO SECTIONS 10A AND 10B.

The definition of
“computer software” stipulated under Explanation 2 to sections 10A and 10B
includes “any customized electronic data or any product or service of similar
nature, as may be notified by the Board….”. The CBDT had already issued
Notification No. 890(E) dated 26.09.2000 specifying such items. The notification
includes Engineering and Design but does not specifically include
Research and Development activities related to software development in respect
of which clarification has been sought.

After examining
the matter, it is clarified that the services covered by the aforesaid
Notification, in particular, the ‘Engineering and Design’ do have the inbuilt
elements of Research and Development. However, for the sake of clarity, it is
reiterated that any Research and Development activity embedded in
the ‘Engineering and Design’, would also be covered under the said Notification
for the purpose of Explanation 2 to the above provisions.

(iv) WHETHER
TAX BENEFITS UNDER SECTIONS 10A, 10AA AND 10B WOULD CONTINUE TO REMAIN
AVAILABLE IN CASE OF A SLUMP-SALE OF A UNIT/UNDERTAKING

The vital factor
in determining the above issue would be facts such as how a slump-sale is made
and what is its nature. It will also be important to ensure that the slump sale
would not result into any splitting or reconstruction of existing business.
These are factual issues requiring verification of facts. It is,
however, clarified that on
the sole ground of change in ownership of an undertaking, the claim of
exemption cannot be denied to an otherwise eligible undertaking and the tax
holiday can be availed of for the unexpired period at the rates as
applicablefor the remaining years, subject to fulfilment of prescribed
conditions.

(v) WHETHER IT IS NECESSARY TO MAINTAIN SEPARATE BOOKS OF ACCOUNT FOR AN

ASSESSEE IN RESPECT OF ITS ELIGIBLE UNITS CLAIMING TAX BENEFITS UNDER

SECTIONS 10A AND 10B.

Since there is no requirement in law to maintain separate books of
account, the same cannot be insisted upon. However, since the deductions under
these sections are available only to the eligible units, the Assessing Officer
may call for such details or information pertaining to different units to
verify the claimand quantum of
exemption, if so required.

(vi) WHETHER TAX BENEFITS UNDER SECTION 10AA CAN BE ENJOYED BY AN ELIGIBLE

SEZ UNIT CONSEQUENT TO ITS TRANSFER TO ANOTHER SEZ.

This issue relates to cases where an eligible SEZ unit is shifted from one SEZ to another SEZ on account of commercial exigencies. This shifting is permissible under Instruction No.59 (F.No.C-4/2/2010-SEZ) issued by Department of Commerce (SEZ Division), provided approval from the Board of Approvals

(BOA) has been obtained. Doubts have been raised whether such shifting of an eligible unit would deprive the unit/undertaking of tax benefits, provided there is no splitting or reconstruction of an existing business.

The matter has been examined and it is clarified that the tax holiday should not be denied merely on the ground of physical relocation of an eligible SEZ unit from one SEZ to another in accordance with Instruction No. 59 of Department of Commerce (referred to above) and if all the prescribed conditions are satisfied

under the Income-tax Act, 1961. It is further clarified that the unit so relocatedwill be eligible to avail of the tax benefit for the unexpired period at the rates applicable to such years.

(vii)WHETHER NEW UNITS/UNDERTAKINGS SET UP IN THE SAME LOCATION WHERE

THERE IS AN EXISTING ELIGIBLE UNIT/UNDERTAKING WOULD AMOUNT TO

EXPANSION OF THE EXISTING UNIT/UNDERTAKING

Whether setting up of new unit/undertaking in a location (covered by sections10A, 10AA or 10B), where an eligible unit is already existing, would amount to expansion of such already existing unit is a matter of fact requiring examination and verification. However, it is clarified that setting up of such a fresh unit in

itself would not make the unit ineligible for tax benefits, as long as the unit is setup after obtaining necessary

approvals from the competent authorities; has not been formed by splitting or reconstruction of an existing business; and fulfils all other conditions prescribed in the relevant provisions of law.